10. Finance and accounting

Exam analysis

Most tested topics

10.1 Financial statements

A statement of profit or loss reports financial performance over a period: revenue earned, costs/expenses charged and resulting profit. It supports trend/target/competitor analysis and decisions, but accounting profit is not the same as cash flow.

Line/cascade	Meaning
Revenue	Income from ordinary sales before deducting costs
less Cost of sales	Direct cost of goods/services sold (often opening inventory + purchases/production cost − closing inventory)
= Gross profit	Amount available to cover operating expenses and profit
less Expenses	Operating costs not included in cost of sales
= Profit from operations / operating profit	Profit generated by core operations
less Taxation	Tax charge on profit
= Profit for the year	Profit attributable after tax for the period
less Dividends	Distribution to shareholders from profit (not an operating expense)
= Retained earnings for the period	Profit kept in business, added to retained-earnings reserve subject to other changes

Given change, other things equal	Statement impact
Revenue increases $20k with cost of sales unchanged \| Revenue, gross/operating/profit before tax rise$ 20k; tax may rise
Cost of sales increases $8k \| Gross profit and downstream profit fall$ 8k
Operating expense/depreciation increases $5k \| Operating profit and downstream profit fall$ 5k; gross profit unchanged
Tax charge increases $2k \| Profit for year falls$ 2k; operating/gross profit unchanged
Dividend increases $3k	Retained amount/equity/cash falls; profit for year and operating profit unchanged

For an amendment: identify amount and classification → change that line once → recalculate every downstream subtotal → apply any stated tax/dividend effect → trace linked statement-of-financial-position item. Do not change unrelated upstream subtotals.

Interpret with accounting policy/estimates, one-off items, inflation, seasonality, scale/product mix and cash/balance-sheet evidence. Revenue/profit can rise while receivables, inventory or borrowing create liquidity risk.

Profit is a period measure based on accruals and non-cash charges. Dividends distribute profit; they do not reduce operating profit. A single line change must flow only through the appropriate downstream totals.

A statement of financial position is a snapshot at one date of assets/resources controlled, liabilities/obligations and equity/residual owner financing. It indicates asset structure, liquidity, long-term debt and accumulated financing—not market value or cash performance by itself.

Section	Meaning/examples
Non-current assets	Longer-term operating resources such as property/equipment at carrying amount
Current assets	Expected to turn into cash/use within operating cycle: inventory, trade receivables, cash
less Current liabilities	Due within short term: trade payables, overdraft/accrual/tax due
= Net current assets	Current assets − current liabilities (working-capital position)
Non-current assets + net current assets = net assets before long-term claims	Resource amount after short-term obligations
less Non-current liabilities	Longer-term loans/obligations
= Net assets	Residual funded by equity/reserves
Equity and reserves	Share capital plus retained/other reserves; equals net assets

$Assets = Liabilities + Equity; Net current assets = Current assets - Current liabilities; Net assets = Equity and reserves$

Profit/loss item/change	Financial-position relationship
Credit revenue	Raises profit and trade receivables until cash collected
Expense incurred but unpaid	Lowers profit and raises current liability
Profit retained	Adds to retained-earnings reserve/equity; corresponding assets/liabilities reflect underlying transactions
Dividend paid	Reduces cash and retained earnings/equity; does not reduce operating profit
Closing inventory	Current asset and deduction in cost of sales; higher valid value raises profit/equity
Depreciation	Expense lowers profit/retained equity and accumulated depreciation lowers non-current asset carrying amount
Tax charge unpaid	Lowers profit and raises tax/current liability until paid

Amend by identifying at least two linked effects and preserving the equation. Buying equipment for cash swaps current asset for non-current asset; buying with a long-term loan raises asset and non-current liability; collecting receivable swaps receivable for cash and creates no new revenue/profit.

Equity is the residual claim, not a cash account available to spend. 'Current' concerns operating-cycle/short-term classification, not importance. A balanced statement can still contain poor estimates or weak liquidity.

Inventory valuation is difficult when purchase/production costs vary, units are interchangeable or partly completed, overhead allocation is uncertain, and goods become damaged, obsolete, seasonal or slow-moving. Quantity/cut-off and expected selling/completion/disposal costs also require evidence.

$Net realisable value (NRV) = estimated selling price - estimated costs to complete - estimated costs to sell$

Value each relevant inventory item/group at the lower of its cost and NRV. Cost represents attributable acquisition/conversion cost; NRV represents expected recoverable amount from sale. The lower-value rule prevents recognising profit before sale and avoids overstating assets/profit when recovery has fallen.

Item cost = $72. Expected selling price =$ 80, completion cost = $7 and selling cost =$ 4, so NRV = $69. Report inventory at$ 69 and recognise a $3 reduction/expense. If NRV were$ 76, report at cost $72—not at the higher expected gain.

Valid closing-inventory valuation change, other things equal	Impact
Closing inventory reduced/write-down	Cost of sales rises; gross/operating/profit for year and retained equity fall; current assets/net assets fall
Closing inventory increases because more valid units/cost	Cost of sales falls and reported profit/current assets rise, but cash may be tied up and obsolescence risk may worsen

Support estimates with count/cut-off, purchase/production records, age/condition, post-period selling prices, return/discount history and completion/disposal plans. Apply consistent classifications and update NRV when evidence changes.

NRV is not selling price: completion and selling costs are deducted. Inventory is not written up above cost for expected profit, and higher reported inventory/profit is not automatically stronger cash or performance.

Depreciation systematically allocates the depreciable amount of a non-current asset over its estimated useful life as it helps generate activity/revenue. It matches expense to periods and prevents non-current assets/profit from remaining overstated; it is not a valuation forecast or replacement cash fund.

$Annual straight-line depreciation = (asset cost - estimated residual value) / estimated useful life$

Machine cost $110,000, residual value$ 10,000, useful life 5 years: annual depreciation = ( $110,000 −$ 10,000) ÷ 5 = $20,000. After 3 full years, accumulated depreciation =$ 60,000 and carrying amount = $110,000 −$ 60,000 = $50,000.

Statement	Straight-line impact for the period
Profit or loss	Depreciation expense increases; operating profit, profit for year and retained amount fall, other things equal
Financial position	Non-current asset carrying amount falls through accumulated depreciation; retained earnings/equity/net assets fall through lower profit
Cash	No current cash outflow from recording depreciation; cash was affected when asset was bought/financed, though lower taxable profit may affect tax

For an amendment, calculate period charge from stated cost, residual value and useful life; add it to expenses; recalculate profit and retained earnings; increase accumulated depreciation/reduce carrying amount by the same pre-tax charge, applying any stated tax effect separately. Review useful-life/residual estimates when evidence changes.

Straight line is simple and gives equal annual charge, suitable when benefits are consumed evenly. Actual usage, maintenance, technology/obsolescence and market value may change unevenly, so carrying amount does not claim to equal resale value.

Depreciation is a non-cash expense allocation, not money placed aside and not necessarily market-value decline. Land or assets with no depreciable amount are not automatically treated like finite-life equipment.

10.2 Analysis of published accounts

Liquidity is the ability to convert available current assets/cash inflows into payment of short-term obligations on time. It matters for wages/suppliers/tax/debt continuity, credit/reputation and survival; a profitable business can still fail from cash timing.

Diagnose cash cycle and quality of components: inventory sale time/obsolescence, credit sales and collection, supplier/payment dates, cash buffer/overdraft, seasonality, forecast uncertainty and access to finance. Excess liquidity can mean idle cash/stock and weak return.

Method	Liquidity mechanism	Trade-off
Reduce/accelerate inventory	Releases cash and storage/obsolescence cost	Stockout, lost sales/scale or rush supply
Faster receivables: credit checks, invoicing, reminders, discount/factoring	Cash arrives earlier	Lost margin/customers, factoring fee/reputation
Negotiate longer payables	Delays cash outflow	Lost discount/trust/supply or higher price
Improve cash sales/margin/cost and phase investment	More internal cash / lower outflow	Demand, quality/capability or long-term growth harm
Sell idle assets, inject equity or refinance short debt long-term	Immediate cash or later repayment	Lost capacity, dilution, interest/fees and not a cure for weak operations

Do not maximise a ratio blindly or confuse profit with cash. Choose methods by root cause, speed, scale and impact on customers, suppliers, capacity, profit and long-run viability.

$Current ratio = Current assets / Current liabilities; Acid-test ratio = (Current assets - Inventory) / Current liabilities$

Current assets $0.6m and current liabilities$ 0.8m give current ratio 0.75:1. If inventory is $0.2m, acid test = ($ 0.6m − $0.2m) ÷$ 0.8m = 0.50:1. Ratios have no currency or percentage unit.

Compare over time, plan/industry/business model and underlying cash conversion. A fall may signal pressure, but a lean cash retailer can operate below a manufacturer's ratio; a high ratio may hide obsolete inventory, overdue receivables or idle cash. The acid-test gap reveals inventory dependence, not inventory quality.

Event	Immediate ratio caution
Collect receivable	Swaps current assets; totals/ratios usually unchanged
Pay current liability with cash	Both numerator and denominator fall; direction depends on starting ratio
Buy inventory for cash	Current ratio unchanged; acid-test numerator falls
Convert short-term loan to long-term	Current liabilities fall, ratios improve but interest/debt remains

A benchmark such as 2:1 or 1:1 is not a universal target. Interpret composition, timing and cash flows, not ratio alone.

Profitability is the ability to generate profit relative to revenue or resources invested. It funds reinvestment, resilience, debt service and owner return; distinguish it from absolute profit, cash flow and growth.

Improvement route	Mechanism	Risk/condition
Raise price/improve mix/differentiation	More gross profit per unit	Elastic demand, competitor/brand response and volume
Grow profitable volume	Spreads fixed cost and raises contribution	Capacity, working capital, promotion and cannibalisation
Lower input/process/waste cost	Raises gross/operating margin	Quality, supply, employees and resilience
Reduce/control operating expenses	Raises operating margin	Cutting R&D/training/service may damage future revenue
Use/sell/redeploy capital assets better	Raises ROCE through profit or lower capital employed	Capacity/flexibility/growth and one-off sale

Decompose weak ratio into price, volume/mix, unit cost, operating expense and capital utilisation; compare trend/benchmark and external factors; choose root-cause intervention; forecast customer/employee/cash/capacity effects; monitor sustainable margin and ROCE rather than one-year cuts.

Higher short-run margin from underinvestment can reduce future profitability. A smaller business can have higher margins but lower absolute profit; diagnose the relevant relationship.

Ratio	Cambridge formula	Primary question
Gross profit margin	Gross profit ÷ revenue × 100	How much sales value remains after cost of sales?
Profit margin / operating profit margin	Profit from operations ÷ revenue × 100	How much sales value remains after cost of sales and operating expenses?
ROCE	Profit from operations ÷ capital employed × 100	How effectively is long-term capital generating operating profit?

$Capital employed = Issued share capital + Reserves + Non-current liabilities$

Revenue $10.8m, cost of sales$ 6.4m, expenses $3.9m: gross profit$ 4.4m and operating profit $0.5m; GPM = 40.74%, operating margin = 4.63%. If capital employed$ 8m, ROCE = 6.25%.

If GPM falls, investigate selling price/mix and input/direct production cost. If GPM stable but operating margin falls, investigate operating expenses. ROCE can change because operating margin changes, asset/capital utilisation changes, or both. Compare like accounting definitions, time, industry and risk.

Use profit from operations—not gross profit or profit for year—for operating margin and ROCE under this syllabus. A higher ratio may arise from underinvestment or asset sale, so inspect causes.

Financial efficiency is how effectively working-capital resources are converted through operations into sales and cash. Inventory turnover and trade receivable/payable days expose cash-cycle speed, operating quality and relationship choices.

Area/improvement	Benefit mechanism	Trade-off
Inventory: forecast, JIT/reorder, range/slow-stock action, supplier/process reliability	Less cash/storage/obsolescence and faster turnover	Stockout, lost scale/sales and disruption
Receivables: credit checks/limits, clear terms/invoice, reminders, early discount/factoring	Faster cash and less bad debt	Lost customers/margin, admin/factoring cost
Payables: negotiate terms, schedule accurately, consolidate purchasing	Retains cash longer	Lost discount, price increase, supplier trust/supply
Process/data: ERP and cross-functional working-capital ownership	Visibility, fewer errors/delay and matched decisions	System/data/training cost and metric gaming

Compare trends, sector/business model, terms and demand/supply conditions; inspect aged inventory/receivables/payables and cash forecast. A long payable period may improve cash but signal distress; fast inventory may show efficiency or insufficient availability. Optimise total contribution, service, risk and relationships.

Faster is not universally better. Financial efficiency is not achieved by starving operations or suppliers of necessary working capital.

Ratio	Formula	Unit
Rate of inventory turnover	Cost of sales ÷ average inventory	times per year
Inventory turnover (days, if requested)	Average inventory ÷ cost of sales × 365	days
Trade receivables turnover	Average trade receivables ÷ credit sales × 365	days
Trade payables turnover	Average trade payables ÷ credit purchases × 365	days

$Average balance = (Opening balance + Closing balance) / 2$

Cost of sales $0.40m and average inventory$ 0.13m: turnover = 3.08 times (or 118.6 days). Receivables $1.4m and credit sales$ 5m: days = $1.4m ÷$ 5m × 365 = 102.2 days.

Higher inventory times/lower days usually releases cash but can mean stockouts; lower receivable days speeds cash but may reflect restrictive credit; higher payable days retains cash but can damage supplier terms. Compare actual credit flows and average balances; if only closing/all-sales/purchases data exist, state the approximation.

Inventory turnover uses cost of sales, not revenue, and 'rate' answer is times—not money, percent or days. Match receivables to credit sales and payables to credit purchases wherever data permit.

Gearing measures the proportion of long-term capital employed financed by non-current liabilities/debt. It matters because interest/repayment are fixed claims: debt can fund growth without ownership dilution and amplify shareholder return when operating return exceeds debt cost, but increases cash, covenant, refinancing and failure risk.

Interpret with interest rates/coverage, cash stability, asset collateral, industry cyclicality, lender covenants, maturity/currency, growth opportunity and owner control—not a universal high/low cut-off. A capital-intensive utility can sustain a different level from a volatile start-up.

Reduce gearing method	Mechanism	Trade-off
Retain profit and repay debt	Debt falls/equity reserves rise	Less dividend/cash and slower growth
Issue shares/new equity	Capital employed equity rises and cash can repay debt	Dilution, issue cost and owner control
Sell non-core assets to repay debt	Debt and fixed claims fall	Lost capacity/income and sale timing/value
Refinance/restructure	Longer term/lower cost may reduce immediate risk	May not reduce ratio; fees/interest/covenants
Improve operating cash/profit	Supports repayment and resilience	Takes time and does not directly change ratio until retained/repaid

Low gearing is not automatically optimal: unused debt capacity can forgo profitable investment. Equity also has opportunity/control costs even without compulsory interest.

$Gearing ratio = Non-current liabilities / Capital employed × 100$

$Capital employed = Issued share capital + Reserves + Non-current liabilities$

Non-current liabilities $10m and capital employed$ 16m give gearing = $10m ÷$ 16m × 100 = 62.5%. State 62.5%, not 0.625 or $62.5.

A rise means a larger share of long-term capital carries debt claims, usually increasing sensitivity to interest/cash downturn and potentially shareholder leverage. Diagnose whether debt rose, equity/reserves fell or both; compare trend, sector, maturity/rates and use of funds. Profitable debt-funded expansion can raise both risk and return.

Use the syllabus denominator, not debt ÷ equity or assets. The percentage alone does not reveal repayment dates, interest affordability, cash volatility or asset quality.

Shareholder return comes from cash dividends and changes in share value, supported by sustainable earnings/cash, risk and growth expectations. Dividend yield measures cash return relative to market price; cover measures dividend sustainability; P/E reflects price paid per unit of earnings and market expectations/risk.

Judge trends and alternatives: dividend/yield/cover/P-E, profit/margins/ROCE, cash/liquidity/gearing, share-price movement, risk, inflation/interest, business objective/life cycle and shareholder preference. A low current dividend may be acceptable if retained funds create credible higher future return.

Method	Possible return mechanism	Risk/trade-off
Raise sustainable profit/cash through strategy/efficiency	More dividend capacity and future valuation	Execution risk/time/investment
Increase dividend / regular policy	Higher immediate cash return and confidence	Lower cover/reinvestment/cash and possible borrowing
Retain and invest in positive-return projects	Future earnings/share value	No guarantee, delay and agency risk
Reduce risk/gearing, improve disclosure/governance	Lower required return/more confidence	Debt repayment/opportunity/implementation cost
Share buyback if appropriate	Fewer shares and possible EPS/price support	Uses cash, timing/valuation and may mask weak investment

A higher dividend is not automatically better if it weakens cover, liquidity or valuable investment. Market price—and therefore yield/P-E—can change because expectations and external markets change without current operating action.

Ratio	Formula	Unit/meaning
Dividend yield	Dividend per share ÷ market price per share × 100	% cash return at market price
Dividend cover	Profit for year ÷ total annual dividends (or EPS ÷ dividend per share on consistent basis)	times earnings cover dividend
Price/earnings (P/E)	Market price per share ÷ earnings per share	times price relative to current earnings

Dividend per share $0.03 and market price$ 0.40: yield = 7.5%. Profit for year $4m and dividends$ 1m: cover = 4 times. Price $4.00 and EPS$ 0.60: P/E = 6.67 times.

Higher result can indicate	But may also indicate
Yield: more cash return	Falling share price/risk or unsustainable dividend
Cover: safer dividend/reinvestment capacity	Low payout despite shareholder income needs
P/E: strong growth/quality expectations	Overvaluation; low P/E may reflect risk or undervaluation

When comparing yield, calculate each year using that year's dividend and price. A move from 7.5% to 5.7% is −1.8 percentage points; relative change is −1.8 ÷ 7.5 × 100 = −24%. Do not call these the same measure.

Do not mix total profit with per-share dividend or EPS with total dividend. Ratios need trend, competitor/market, accounting policy, cash, risk and growth evidence; investor return includes capital gain/loss not captured by dividend yield alone.

10.3 Investment appraisal

Investment appraisal uses forecast costs, cash flows/profits, timing and decision criteria to compare long-term capital projects before committing scarce, often irreversible resources.

Need	Decision value
Scarce finance and mutually exclusive alternatives	Prioritises projects/locations and opportunity cost
Large sunk/irreversible cost and long life	Tests recovery, return and value before commitment
Cash timing/liquidity and risk	Exposes when funding is tied up and downside occurs
Objectives/accountability	Applies hurdle/maximum-payback criteria and records assumptions
Cross-functional planning	Connects demand/price/cost to capacity, people, location and finance

Define incremental initial/working-capital outflows, annual operating cash inflows/outflows, useful life, residual/disposal value, accounting profit, timing, discount rate/finance cost, tax/inflation if provided, capacity interactions and base/high/low assumptions. Exclude irrelevant sunk costs already incurred.

Clarify objective/constraint → forecast incremental evidence and scenarios → calculate payback, ARR and NPV consistently → compare hurdle/ranking and method limitations → test strategic/operational/stakeholder factors → recommend with conditions, funding/implementation and review/exit triggers.

Appraisal is only as reliable as forecasts and definitions. It does not guarantee success or replace due diligence, finance availability, capacity, legal/ethical and strategic judgement.

Payback is the time taken for cumulative net cash inflows to recover the initial investment. Cumulate annual inflows until the unrecovered balance enters a year; for even flow within that year: fraction of year = amount still unrecovered at start of year ÷ that year's net cash inflow.

Initial cost $320m; after year 5 cumulative inflows are$ 310m and year-6 inflow is $120m. Remaining$ 10m; fraction = 10 ÷ 120 = 0.0833 year = 1 month. Payback = 5 years 1 month.

$ARR = Average annual profit / Average investment × 100; Average investment = (Initial investment + Residual value) / 2$

Average annual profit = total accounting profit over project life ÷ number of years. If only total net cash flows and depreciation information are provided, derive profit consistently. Example average profit $0.20m and average investment$ 0.95m: ARR = 21.05%. Use %; do not divide by initial investment under this syllabus.

Method	Prefer	Strength	Limitation
Payback	Shorter or within maximum	Simple, cash/liquidity/risk exposure and fast obsolescence	Ignores post-payback flows, time value within comparison and total return
ARR	Higher or above target	Uses all project years/profit and familiar % comparison	Accounting profit/estimates, average-investment convention, no cash timing/time value and scale difference

Payback and ARR answer different questions and may rank projects differently. Neither discounts cash flows; neither alone proves strategic or financial feasibility.

Net present value (NPV) is the total present value of a project's future net cash flows minus/inclusive of the initial investment. Discounting recognises time value and required return/opportunity cost: a future dollar is worth less today.

$Present value in year t = Net cash flow in year t × Discount factor in year t; NPV = Sum of all present values including initial outflow$

List each year including time 0 → calculate annual net cash flow → multiply each future flow by the supplied discount factor → include residual/working-capital recovery in its year if stated → sum discounted inflows/outflows → subtract initial cost once (or include it as negative at time 0). Preserve signs and monetary unit.

Time	Net cash flow	Present value
0	− $100,000 \| 1.000 \| −$ 100,000
1	$60,000 \| 0.909 \|$ 54,540
2	$60,000 \| 0.826 \|$ 49,560
Total NPV		+$4,100

At the chosen discount rate: positive NPV is forecast to exceed required return/add present value; zero just meets it; negative falls short. For comparable mutually exclusive projects, higher NPV is quantitatively preferred, subject to capital/risk/scale/life and qualitative factors. NPV is money, not percent.

Sensitive to cash-flow/timing/life/residual and discount-rate forecasts; one rate may not reflect changing/project risk; ranking can favour larger projects; cash constraints and non-financial impacts remain; precise result creates false confidence. Run scenarios/sensitivity and update.

Positive NPV is a forecast conditional on discount rate and cash flows, not guaranteed accounting profit or cash availability. Never discount the initial outflow twice or omit negative signs.

Quantitative evidence	Decision contribution	Shared/individual limitation
Payback	Liquidity, exposure and speed of recovery	Ignores after-payback/time value
ARR	Average accounting return versus target	Profit not cash; no timing/time value
NPV	Time-valued cash contribution at required return	Discount/cash forecasts and scale/life differences
Forecast/scenario/capacity/finance	Affordability, downside and operational consequences	All rely on uncertain assumptions/data

Qualitative/strategic factor	Impact on choice
Fit with objectives/brand/market need and alternative opportunity	Value not captured by near-term cash and opportunity cost
Technical feasibility, capacity/site/supplier, quality and implementation time	Determines whether forecast cash is deliverable
People skills/jobs/relations, management capability and culture/change	Adoption, productivity, ethics and disruption
Law, safety, environment/community/reputation and stakeholder response	Licence to operate, risk and long-run value
Competition/technology/obsolescence, flexibility and exit/reversibility	Forecast life/downside and strategic option value

Reconcile results: verify same assumptions/life/bases → explain why methods disagree → identify binding objective/constraint (cash, return, value, timing) → test high/base/low and break-even assumptions → compare qualitative fit/implementation → recommend project/location with conditions, funding, risk controls, milestones and stop/review triggers.

A decision may accept slower payback for a much stronger positive NPV and strategic capacity, or reject attractive ARR because cash, skills, demand evidence or safety is inadequate. State which factor is most important now and what new evidence would change the recommendation.

Financial information is rarely sufficient alone, and qualitative does not mean unmeasurable or vague. Connect each factor to forecast deliverability, stakeholder risk or objectives and compare its weight.

10.4 Finance and accounting strategy

Use financial statements to establish revenue/profit/cost trends, asset/capacity/working capital, cash/liquidity, debt/equity/gearing, investor return and investment capability. Translate findings into strategic constraints/objectives/options, forecast each option's statement/ratio effects, fund/implement, then monitor actual versus assumption. Accounts inform strategy; they do not generate it.

Annual-report content	Evidence/use	Main caution
Chair/CEO and strategic/business review	Model, objectives, market, performance, risks and outlook	Selective narrative/optimism and forward-looking uncertainty
Directors/governance/remuneration/ownership	Leadership, controls, incentives, accountability and conflicts	Formal compliance does not prove culture/effectiveness
Profit/loss, financial position, cash-flow/changes in equity	Performance, resources/claims, cash and distributions	Historical, aggregated and policy/estimate dependent
Notes/accounting policies/segments/commitments/contingencies	Definitions, breakdowns, debt, risks and comparability	Complexity, judgement and materiality exclusions
Independent auditor report	Opinion on whether statements meet reporting framework/material fairness	Reasonable—not absolute—assurance; not viability/strategy forecast
Sustainability/employee/community/risk information	Non-financial capability, licence/reputation and long-term exposure	Measures/assurance/greenwashing and comparability vary

Stakeholder	Questions supported	Additional evidence needed
Managers/directors	Resources, performance gaps, finance/capacity and strategic control	Current internal operational/customer/competitor forecasts
Existing/potential shareholders	Profit/return/growth/risk/governance and buy/hold/sell	Market price, alternatives, risk appetite and current news
Lenders/suppliers	Liquidity, cash generation, gearing, collateral and repayment	Forecast cash, covenants, order/payment history
Employees/unions	Security, pay capacity, investment and strategy	Workforce plans, skills, conditions and consultation
Customers/government/community	Continuity, tax/compliance, social/environmental impact	Product/service/regulatory and independently verified impact data

Define stakeholder/strategy question → identify relevant section and assurance → calculate trends/ratios/segment effects with consistent definitions → triangulate narrative, notes, cash and non-financial/external evidence → test alternative explanation/scenario → decide with conditions and monitoring measures.

An annual report is more than the primary statements, and an audit opinion is not a guarantee of future performance, ethical conduct or share value. Stakeholders need question-specific, current and comparative evidence.

Assess performance by calculating consistent ratios and absolute data across several years, budgets and suitable competitors/industry; decompose numerator/denominator and link changes to prices, volumes, costs, assets, working capital and financing. Adjust/qualify differences in scale, product/geography, year end, accounting policies and one-offs.

Strategic choice	Likely immediate ratio/data pathways (other things equal)	Longer-term judgement
Debt finance investment	Cash/assets and non-current liabilities rise; gearing rises; capital employed rises; interest/cash claims increase	ROCE/margins/liquidity improve only if operating return/cash exceeds financing and project risk
Equity finance investment	Cash/assets, share capital and capital employed rise; gearing falls; ownership/EPS/dividend base dilutes	Return depends on project profit growth versus added capital and control cost
Higher dividend	Cash/current assets and retained reserves fall; liquidity/cover fall; yield may rise at unchanged price; gearing may rise as capital employed/equity falls	Can signal confidence/satisfy income but restrict resilience/investment
Retain/lower dividend	Cover/cash/reserves improve; current yield may fall	Valuable only if retained projects earn adequate return; agency risk
Organic growth/new capacity	Revenue/inventory/receivables/assets/cost rise at different times; liquidity/efficiency/ROCE may initially worsen	Scale/learning/margin/cash may improve after utilisation and demand develop
Acquisition	Assets/debt/equity/goodwill and ratios shift immediately; comparability break	Synergy/integration, hidden liability, culture and finance determine outcome
Price/cost/quality/working-capital strategy	Changes revenue, gross/operating margins, turnover days, liquidity and customer/supplier effects	Optimising one ratio can harm volume, quality, relationships or future capability

Ratios can influence strategy: weak liquidity may favour phased growth/equity/working-capital action; high gearing may constrain debt and increase required project return; weak margins may require positioning/process diagnosis; low turnover may trigger inventory/credit redesign. But a ratio signals a question, not its cause or automatic remedy.

Published-account/ratio limitation	Consequence/control
Historical, annual and point-date data; seasonality/window dressing	Add current/monthly cash/operational evidence and multiple periods
Accounting policy/estimate/classification, inflation and one-offs	Read notes, restate/qualify comparability and use real/segment data
Aggregation hides product/site/country/customer differences	Use segment/internal/unit economics
Different size/model/geography/year end/capital structure	Select suitable peers and common definitions
Ratios omit quality, people, innovation, market, ESG and risk	Combine non-financial/external/forward forecasts
Correlation and strategic time lags	Trace mechanism, scenarios and leading/lagging measures
Market-price ratios reflect external expectations	Separate operating performance from market sentiment/rates

Decision method: define objective → compare trend/peer and components → identify multiple plausible causes → connect candidate strategy to statement/ratio changes over implementation and steady state → forecast high/base/low with finance/dividend/growth interactions → add non-financial feasibility/risk → choose and monitor a balanced set; revise when assumptions fail.

A 'better' ratio can be mechanically created by shrinking investment, delaying suppliers or cutting capability. Judge whether the strategy creates sustainable cash, customer value and risk-adjusted return—not whether one published number moves in the preferred direction.

10. Finance and accounting

Exam analysis

Most tested topics

10.1 Financial statements

The statement of profit or loss explains period income, costs and retained earnings

The statement of financial position balances resources with financing claims

Inventory is reported at the lower of cost and net realisable value

Straight-line depreciation allocates asset cost and reduces carrying value

10.2 Analysis of published accounts

Liquidity is the ability to meet short-term obligations when cash is due

Current and acid-test ratios compare liquid resources with short-term claims

Profitability measures sustainable profit from sales and capital

Profitability ratios isolate gross, operating and capital performance

Financial efficiency manages cash tied in inventory, receivables and payables

Efficiency ratios match average balances to their operating flows

Gearing balances leverage benefits against fixed financial claims

The gearing ratio compares non-current liabilities with capital employed

Investor return combines cash dividends, retained growth and market expectations

Investment ratios separate cash yield, dividend cover and earnings expectations

10.3 Investment appraisal

Investment appraisal structures long-term choices under scarce finance and uncertainty

Payback measures cash recovery; ARR measures average accounting return

NPV values each future net cash flow in today's money

Investment decisions combine method results with strategic feasibility and risk

10.4 Finance and accounting strategy

Annual reports combine performance, position, governance and strategic context

Strategy changes ratio numerators, denominators, timing and risk